Internal controls
Foreign auditors in China are being squeezed on all sides
THE big global accounting firms are not having an easy time of it in China. They have been caught up in the accounting scandals that have engulfed many Chinese firms that listed on America’s stock exchanges: on May 9th, for example, America’s Securities and Exchange Commission (SEC) took legal action against Deloitte’s Shanghai arm in a case involving an unnamed Chinese client. The next day Chinese officials unveiled details of a plan that will force foreign partners to hand control of the “Big Four” firms—Deloitte, Ernst & Young, KPMG and PwC—to Chinese colleagues by the end of 2017.
At first blush, the SEC seems to be overreaching by pursuing auditors based in China which are already regulated by local authorities. And the localisation scheme appears to be yet another example of the pitch being queered for foreign firms by an overweening Chinese state. But the snap judgments are misleading.
The American regulatory mandate abroad arises because many Chinese firms choose to list on America’s exchanges while still using auditors based in China. One such example is Longtop, a Chinese business-software firm that used Deloitte’s Shanghai arm to do its books. The auditor resigned a year ago after it claimed to have identified a number of “very serious defects” during its audit for the financial year that ended in March 2011. But Deloitte’s Chinese partners refuse to hand over the work papers arising from the Longtop audits to the SEC on the ground that doing so would violate local law. The Chinese invoke the need to defend both sovereignty and (more dubiously) “state secrets”.
The snag is that under the Sarbanes-Oxley law, American regulators are obliged to conduct periodic inspections of the auditors of all firms listed on American exchanges. The Public Company Accounting Oversight Board (PCAOB) is required to inspect all of the relevant accounting firms based abroad by year-end, but China has blocked access for years. James Doty, the agency’s boss, says China may now be willing to let his inspectors tag along during Chinese audits. In time, he hopes an accord can be reached on joint inspections.
The consequences could be dire if the Chinese continue to block co-operation. Paul Gillis, a former accountant now teaching at Peking University, points out that if the Chinese accountants are not audited by the PCAOB, the agency may be forced to deregister them all. That would force their clients listed in America eventually to face delisting themselves for not having a registered auditor. Worse yet, multinationals will not want their Chinese divisions audited by deregistered firms.
That is not the only threat. The new localisation rules will force the Big Four to hand over the reins to local partners soon. As long as this is done in an orderly fashion, this need not be a bad thing. Mr Gillis says local accountants are a bit inexperienced but insists they are as good as those in other countries. James Lee of the ICAEW, a body representing chartered accountants, adds that the new rules leave enough wiggle-room for the old lags to stay on the payroll as well-paid “principals” or consultants.
It is right to point the finger at the Chinese for rejecting international regulatory co-operation. After all, some three dozen countries already co-operate with the PCAOB; more agreements are in the works. But it is wrong to blame China for localising. Given that most other countries already demand that accounting firms be run by local partners, China is merely coming into line with global norms. The Big Four and their clients can only pray it does the same on cross-border co-operation.
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